India has second-highest number of shadow entrepreneurs in the world

Shadow entrepreneurs are individuals who manage a business that sells legitimate goods and services but they do not register their businesses.

| TNN | Updated: May 27, 2014, 21:48 IST

For every business that is legally registered in India, there are 127 shadow businesses that are not.

LONDON: India has the second highest number of shadow entrepreneurs in the world.
For every business that is legally registered in India, there are 127 shadow businesses that are not.

Shadow entrepreneurs are individuals who manage a business that sells legitimate goods and services but they do not register their businesses.

This means that they do not pay tax, operating in a shadow economy where business activities are performed outside the reach of government authorities.

Researchers at Imperial College Business School have found that a large number of shadow entrepreneurs are operating in India who aren't registering their businesses with official authorities, hampering economic growth.

In a study of 68 countries, Professor Erkko Autio and Dr Kun Fu from Imperial College Business School found that after Indonesia, India has the second highest rate of shadow entrepreneurs.

While Indonesia has a ratio of 131 shadow economy businesses to every business that is legally registered, India has 127.
Philippines have 126, Pakistan has 109 and Egypt has 103 shadow businesses to every legally registered business.

This is the first time that the number of entrepreneurs operating in the shadow economy has been estimated.

As these businesses are not registered it takes them beyond the reach of the law and makes shadow economy entrepreneurs vulnerable to corrupt government officials.

The researchers suggest "if India improved the quality of its democratic institutions to match that of Malaysia for example, it could boost its rate of formal economy entrepreneurs by up to 50%, while cutting the rate of entrepreneurs working in the shadow economy by up to a third. This means that the government could benefit from additional revenue such as taxes".

The study says that business activities conducted by informal entrepreneurs can make up more than 80% of the total economic activity in developing countries.

Types of businesses include unlicensed taxicab services, roadside food stalls and small landscaping operations.
The UK exhibits the lowest rate of shadow entrepreneurship among the 68 countries surveyed, with a ratio of only one shadow economy entrepreneur to some 30 legally registered businesses.

The researchers also found that the quality of economic and political institutions has a substantial effect on entrepreneurs registering their businesses around the world.

Professor Autio said "Understanding shadow economy entrepreneurship is incredibly important for developing countries because it is a key factor affecting economic development. We found that government policies could play a big role in helping shadow economy entrepreneurs transition to the formal economy. This is important because shadow economy entrepreneurs are less likely to innovate, accumulate capital and invest in the economy, which hampers economic growth."

The researchers suggest that shadow entrepreneurs are highly sensitive to the quality of political and economic institutions.

Where proper economic and political frameworks are in place, individuals are more likely to become 'formal' entrepreneurs and register their business, because doing so enables them to take advantage of laws and regulations that protect their company, such as trademarking legislation.

The study said "We investigated the influence of economic and political institutions on the prevalence rate of formal and informal entrepreneurship across 18 countries in the Asia-Pacific region during the period 2001-2010. We found the quality of institutions to exercise a substantial influence on both formal and informal entrepreneurship. One standard-deviation increase in the quality of economic and political institutions could double the rates of formal entrepreneurship and halve the rates of informal entrepreneurship. The two types of institutions had a complementary effect on driving entry into formal entrepreneurship, whereas only direct effects were observed for informal entry. Institutions exercise an important influence on individual and firm-level strategic choice, and consequently on the type and form of the resulting economic activity such as entrepreneurship".

Informal entrepreneurs trade legal products and services, yet do not apply for business registration or file any incorporation documents with government authorities. The phenomenon of informal entrepreneurship is seen as a potential driver of job growth and economic development, especially in developing countries.

A recent survey by ILO found that employment in the informal sector provided, on average, approximately 40 % of non-agriculture employment across 39 low and middle-income countries. The informal sector accounts for close to half of all non-agricultural employment in Sub-Saharan Africa, 51 % in Latin America and Caribbean region, and the highest rates, 58 %, are observed in South and East Asia.

A large share of these would qualify as informal entrepreneurs. Informal entrepreneurship also speaks to another important issue for less developed countries, that of poverty. Nearly 1.3 billion people remain in extreme poverty (defined as a daily income of less than $1.25), many of which live in Asia and the Pacific region.

The Imperial researchers said "In this study, we argue that informal sector entrepreneurship, poverty, and inequality are conditioned by a country's economic and political institutions. Non-inclusive political and economic institutions can engender and perpetuate inequality and aggravate poverty. The institutional qualities of a society and its economy — such as economic freedom, the presence of policies that condition the operation of private sector, and institutions regulating the balance of political power and the structure of the bureaucratic system — play an important role in either facilitating or inhibiting economic growth and alleviating poverty".

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